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https://www.barrons.com/articles/money-management-blues-1420259984

Streetwise

Money-Management Blues

By

Lawrence C. Strauss

January 3, 2015

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With the stock market near an all-time high, this would seem to be a golden moment for asset managers’ shares. Yet, the group’s performance was uninspiring in 2014, and analysts are cautious on the outlook for this year.

As of late last year, according to Glenn Schorr, an analyst at EvercoreISI, money-management stocks were up just 7%, versus the broad market’s gain of 11%. Trust bank stocks rose by low double digits, while brokerage shares led the pack, with an increase of 18%.

There was wide variation among individual issues. Shares of
Janus Capital Group
(ticker: JNS) rose 30%, propelled in part by the news that the Denver-based firm had snagged fabled fixed-income manager Bill Gross, who defected from Pimco, the firm he co-founded, amid controversy about his management style and recent investment returns.

BlackRock
(BLK), the world’s largest asset manager, with assets of $4.5 trillion, climbed 13%, slightly ahead of the Standard & Poor’s 500 index.
Invesco
(IVZ) also had a decent year, up 9%.

Waddell & Reed Financial
(WDR), on the other hand, saw its shares sink 24%, amid concern about outflows at two key funds. The $31.3 billion
Ivy Asset Strategy
fund (WASAX), the firm’s flagship portfolio, had an estimated net outflow of $2.6 billion from January through November, according to Morningstar. One of its longtime co-managers, Ryan Caldwell, left the firm and the industry. Also hit by outflows and manager turnover was $9.2 billion
Ivy High Income
(WHIAX), which had an estimated net outflow of $1.3 billion.

The traditional asset-management firms fought battles on multiple fronts last year. For one, nearly 80% of actively managed U.S. stock funds failed to beat their benchmarks in 2014, according to Morningstar. Also, exchange-traded funds and other passive offerings grew even more popular with retail investors. Likewise, investors gravitated to funds that invest in a broad array of assets, not merely stocks and bonds.

So-called alternative strategies, including both buying and shorting stocks, are also catching on in the retail mutual fund world, in some cases making traditional domestic stock funds—the bread and butter of many asset managers—seem old school or unsuited for the times. BlackRock and Invesco are leaders in ETFs and alternative funds, which could explain why their stocks held up well, relative to their peers.

In some ways, 2014 was a catch-up year for traditional asset managers, after their sensational performance in 2013. Many stocks bested the 30% gain of the Standard & Poor’s 500 in 2013, helped by an expansion in price/earnings ratios.

It’s easy to forget, after last year’s showing, how attractive the money-management business can be. It relies heavily on recurring fees, isn’t capital-intensive, and boasts enviable adjusted operating-profit margins. Top players such as BlackRock and Invesco have margins exceeding 40%.

Overall, asset managers “are incredibly profitable and have done a better job on the expense side, leveraging their fixed costs,” says Schorr. Yet the competitive pressures aren’t diminishing, and the stocks aren’t cheap. The group fetches almost 16 times 2015 expected earnings, just below the market’s P/E.

Although there is some optimism about the industry’s prospects in 2015, especially if stocks do well, there is also a sense that investors need to pick their spots. “The group is really much more of a mixed bag,” says Robert Lee, an analyst at Keefe, Bruyette & Woods.

Many analysts have a Neutral rating on industry stalwarts, such as Franklin Resources, T. Rowe Price, and even BlackRock.

SPEAKING OF alternatives,
Affiliated Managers Group
(AMG) could be a more promising bet on the money-management business. The firm’s shares were down 2% in 2014, to $212.24, amid concerns about slower organic growth, after rising 67% in 2013.

Affiliated’s business model is based on buying stakes in boutique asset managers, such as Third Avenue Management and Yacktman Asset Management, and taking a hands-off approach to their operations.

Lee says Affiliated saw about 3% organic growth in the past year’s third quarter, compared with an industry average of nearly zero. Moreover, the stock isn’t overly expensive at 16 times 2015 estimated earnings.

Affiliated shares fell 0.9% Friday, to $210.43. But modest multiple expansion, plus continued organic growth, could help lift the stock this year. “AMG is trying to invest in high-quality, stand-alone investment managers,” says Lee. “The company isn’t going to get it right all of the time, but after two decades, it has a pretty good batting average.”

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